Khan Resources (KRI)

Khan Resources (KRI, $0.43) is a small mining company based in Canada with a market cap of $32 million. Two months ago the company was awarded over $100 million in an international arbitration case. At this point you’re probably tempted to stop reading, open your online broker and start buying shares. While that isn’t the worst idea in the world, this investment certainly isn’t for everybody.

To summarize how Khan got to this point, in 1995 they entered into a joint venture (JV) to develop a uranium mine in Mongolia. The JV consisted of Khan as a 58% owner, a Mongolian state owned company owning 21% and a company majority owned by the Russian government with the other 21%. Importantly, Khan owned 100% of the corresponding exploration license and, through the JV, owned 58% of the mining license. In 2010, the governments of Mongolia and Russia decided to develop the mine themselves and expropriated Khan. Along with this, Mongolia cancelled Khan’s mining and exploration licenses.

In response, Khan brought a case against the Mongolian government for illegal expropriation under the United Nations Commission on International Trade Law (UNCITRAL). Many years ago, private companies that invested in developing countries had no recourse if that country expropriated them. Realizing that potential situation discourages international investment in areas that need it the most, the United Nations adopted the New York Convention in 1958. This convention requires parties to the convention (of which Canada and Mongolia are, along with 153 other countries) to recognize and enforce international arbitration awards. Theoretically, these arbitration cases are confidential, significantly cheaper and quicker than normal court cases, binding and final to all parties (the potential for appeals is very limited) and all awards are to be paid without delay. If the defendant refuses to pay, the winning party is able to seize assets to cover the debt. Companies like Khan feel much safer investing in developing countries like Mongolia knowing they have recourse if relations go south.

Unfortunately for Khan, winning an international arbitration case and collecting the award are two very different things. On March 2, 2015, Khan announced they were awarded over $100M USD in their arbitration case—this sum consisted of an $80M award plus legal fees and interest that is accruing daily. Khan was initially seeking almost $400M from Mongolia so they weren’t exactly thrilled with the result but it’s a lot better than nothing. To make matters worse (and slightly bizarre), Khan’s Chairman, Jim Doak, passed away last month in Mongolia one day after meeting with Mongolian officials (no foul play is suspected). Mongolia has since said they have no plans of paying the $100M. So what now?

Assuming Mongolia flat out refuses to pay (and Khan refuses to settle with them for a lower amount), Khan’s next option seems to be to seize Mongolian assets to cover the debt. The ability of private companies to seize foreign government assets has been hit or miss. Noga Import and Export, who won an arbitration case against Russia, unsuccessfully attempted to seize bank accounts, two jets, a ship and 54 paintings owned by Russia (though the two parties eventually settled). On the other hand, a German businessman was able to seize Russian-owned apartments in Sweden to cover an award owed by Russia. Even if Khan is able to seize Mongolian assets, there is no telling how many years this could take.

Fighting this for years will cost money (which Khan does not have). As of December 31, 2014, Khan had $236k in cash and $650k in investments so we’ll call it $886k available (all numbers Canadian). This is problematic because they are no longer an operating company (they exist solely to fight this case) and have lost an average of $490k the past four quarters meaning they’ll need to raise money in the near future. They also recently hired a third-party specialist to help collect the award. If Khan pays this third-party a fee, their quarterly burn rate will increase. If Khan instead gives them a percent of the eventual reward (which would best align all parties at hand), this will decrease the eventual payout to Khan shareholders.

If you’re curious how small Mongolia, the answer is very. $100M is a large fee for a country whose entire GDP was only $11.5B in 2013. If Mongolia increased taxes to pay this fee, it would be equivalent to $35.71 per citizen (population: 2.8M) which is a lot when you consider their average annual income is only $3,160. In addition, Mongolia is currently facing three other (non-related) arbitration claims.

Given that Mongolia already said they’re not paying, the time value of money is a major factor when considering an investment. It seems most international arbitration cases do eventually get paid (whether through direct payment or seizing assets) but the time period has ranged from a couple months to over a decade in one case involving Russia (if you haven’t noticed, Russia finds themselves on the wrong side of these arbitration cases quite often). How long this thing takes to play out is anybody’s guess, but I’ll pick some numbers out of a hat.

If they have to raise $3M to cover expenses for the next few years and they do so through an equity offering at the current price ($0.43) they’d have a pro forma fully diluted share count of about 90M. If their third-party specialist who is helping to recover the debt gets 10% of the $100M, there would be $90M leftover for Khan shareholders (remember the award is in USD, so roughly $108.7M CAD to Khan at the current exchange rate). If recovery takes three years the reward to current shareholders will get $1.20/share vs the current price of $0.43 which is a CAGR of 40.7%. Quite a result if you ask me! I think that is a relatively optimistic (but still realistic) scenario. The potential for more equity raises, more lawyer/third-party fees and a settlement with the Mongolian government for less than $100M all seem very possible. While losing money on an investment in KRI is possible (e.g. they run out of money and can’t raise equity) I think that’s very unlikely. This could be the classic example of “heads I win; tails I don’t lose much.”

With that being said, the potential results from an investment absolutely run the gamut: from a settlement in the next year for a near 200% CAGR to something that takes ten years to play out and isn’t worth it. Interactive Brokers doesn’t allow access to the Canadian Securities Exchange where KRI is listed so Wiedower Capital will not be investing—I researched the company and situation mostly out of curiosity. Not often does a company win a lawsuit worth over 3x their market cap!

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This blog is for informational purposes only. Everything on this blog is the opinion of Travis Wiedower and should not be taken as investment advice. Clients of Wiedower Capital may maintain positions in securities discussed on this blog.